The Housing Crisis: A Gathering Storm?



The financial news released the other day appeared like a gathering storm.  The first bolts of lightning and rumbles of thunder echoed from Wall Street to Main Street.

JP Morgan announced plans to cut expenses by $1 billion through various cost cutting initiatives including laying off 4,000 employees in the next year.  That caught my attention.

But the real bomb lurked midway through the article.  There it was revealed the bank’s plans to lay off up to 15,000 employees from its mortgage banking unit by the end of 2014.

Ouch!  Isn’t the prevailing wisdom that housing is getting better?

So, Jamie Dimon, what gives?  We both know the hourly and contract employees that will comprise the majority of the layoffs are critical to shepherding a loan package from an originator to funding and to securitizing it.  And wasn’t there something in the Wall Street Journal the other day that your bank may be ignoring some pools of loans in terms of risk analysis?  What say you option arms?

Jamie, what are we going to do with you?  Honestly!

I have been studying the risk associated with mortgages for the last seven years.  Here is my take on the whole situation.

Mortgage banking is out of kilter due to institutional biases and outdated risk analysis of loan packages, as well as the historic economic downturn that started in 2007.  Both factors apply to Fannie Mae and Freddie Mac as well as at institutions such as JP Morgan.  Those who presume that the private sector will be better at the mortgage business than Fannie or Freddie, need to think again.  The whole mess is completely entwined much like art and nature in a Japanese garden.  Here are the big ones in my view:

  • A banking culture that places an over emphasis on loan origination, particularly the refinance, or churning, of existing customers over the quality of loans.  The cycle is reinforced by pay structure based largely on commissions;
  • A rapid increase in government-backed loans, including reverse mortgages;
  • Underwriting regulations that seek to maximize the securitization of loans for the short-term instead of taking a longer view for homeowners and capital markets;
  • An outdated risk analysis that places too much emphasis on consumer credit and loan to value at the expense of income, liquid assets, and loan type;
  • Declining median income that magnifies the risk of owning a home;
  • A servicing industry that presents a conflict of interest;
  • A health care system that results in over 60% of all personal bankruptcies;
  • Consumers with damaged credit that will take years to repair and limit the pool of borrowers;
  • A student loan crisis that may well reinforce and lengthen the credit crisis for decades;
  • Potential austerity measures in government spending that will see reduced employment and/or income at the federal, state, and city level;
  • And last but not least, global economic instability.

So how are we going to get out of this mess?  If housing is going to come back in a sustainable fashion solutions must be fashioned that represent a sea change in thinking.  Tightening existing lending standards, or cutting employees such JP Morgan proposes, only postpones a day of reckoning and hurts the middle class.  I nearly fell off my chair when I read a blog by David H. Stevens, President and CEO of the Mortgage Bankers Association, that stated the “average credit scores and loan to value of denied purchase applications in 2012 was 733 and 81% respectively.”  That’s just extreme and short-sighted.

To begin a slow but steady retreat from the ledge, please find a series of recommendations for consideration:

  • Begin to change the origination culture by redirecting loan officers to review the performance of loans held by existing customers;
  • Incentivize originators toward their new role by offering them a healthy salary with a bonus structure based on the quality of loans submitted not quantity;
  • Stop all cash out refinance transactions, including home equity lines of credit or equity loans.  Homes are not liquid assets;
  • Create a new net benefit standard for refinance applications that requires increased income and liquid assets of at least ten percent over the original loan application;
  • Eliminate the loan to value risk layer for all refinance applications.  Loans do not build equity nor is money exchanged (as compared to a purchase) during a refinance so the value of the home is meaningless;
  • Base income calculations on net income for W-2 employees for fully documented loan applications. Extend to five years the amount of blended income for self-employed or business owners;
  • Decrease the total housing allowance for all borrowers to 30% (using net income), no if, buts, or compensating risk layers;
  • Increase the amount of liquid assets needed to close a conventional loan to one year of a full mortgage payment and two full years for jumbo loans.  The money should be set in an escrow account to be used only for paying the full mortgage payment in the event of a reduction or loss of income;
  • Introduce a new loan based on simple, rather than amortized, interest with mandatory principal payments, as well as built-in modifications; and
  • Suspend all foreclosures immediately until every effort is exhausted to examine all cases and modify loans where possible.

I know these new standards are different.  They are meant to change the ball game from the current standards that are no longer relevant in the 21st century.  Continuing on the same path will only bring more pain.  There truly is no good reason to keep kicking people out of their homes after missing a small percentage of all payments made on time.

More ideas will be forthcoming.  One area that must be addressed very soon is the type of advertisements lenders can run.  When I hear an ad on XM radio pushing consumers to refinance by dangling interest rates, that may or may not be attainable, or the lure of taking cash out of a home, my blood boils.  Plus has anyone from the industry gone to jail yet for what happened in the housing meltdown?

The proportions of the housing crisis are staggering.  It is an onion with endless layers.  Leadership from the public and private sectors is needed to chart a new course.  But make no mistake, a historic storm is continuing to gather.  We do not have the luxury to wait for an advisory to become a warning.

Author: Robert Katula

What say you, the people?